Earnings Call Transcript - BOH Q1 2024

Cindy Wyrick, Director of Investor Relations

Thank you, Marvin. I'd like to welcome everyone and thank you for joining us today as we discuss the financial results for the first quarter of 2024. Joining me today is our CEO, Peter Ho; CFO, Dean Shigemura; our Chief Risk Officer, Brad Shairson; and our IR manager, Chang Park. Before we get started, let me remind you that today's conference call will contain some forward-looking statements. And while we believe our assumptions are reasonable, there are a variety of reasons that the actual results may differ materially from those projected. During the call this morning, we'll be referencing a slide presentation as well as the earnings release, both of these are available on our website, boh.com, under the investor relations link. And now, I'd like to turn the call over to Peter.

Peter Ho, CEO

Thanks, Cindy. Good morning or good afternoon, everyone. We appreciate your interest in Bank of Hawaii. Bank of Hawaii delivered another solid financial performance for the first quarter of 2024. While the net interest margin decreased by 2 basis points for the quarter, we saw significant improvement in direction. Fee income and operating expenses remained steady for the quarter, and credit quality continues to be excellent. Loans and deposits were stable, and our liquidity and capital levels grew. I will start with commentary on funding and then discuss broader market conditions in the Islands. After that, I will pass the call to Brad for a discussion on credit, and Dean will provide more detailed insights on the financials. Let me begin with a bit about our deposits. As many of you know, we consider our deposit franchise to be our crown jewel, developed carefully over our 127-year history, one relationship at a time. This foundation has served us well as market rates and betas have risen in the current rate cycle. Hawaii has a unique deposit market, with five locally headquartered banks holding 97% of the state's FDIC reported deposits. Our deposit base demonstrates remarkable tenure across various customer segments, allowing us to maintain stability and balances during a somewhat turbulent period for the industry. Our deposit franchise has also helped us keep total cost of deposits significantly below industry averages. The increase in total cost of deposits this quarter was just 7 basis points, the smallest rise since the second quarter of 2022, which has helped us improve our beta trajectory. Liquidity levels remain strong, and the employment situation in the islands continues to outperform the broader market. The visitor industry is still affected by the tragic Lahaina fires, with year-to-date February visitor expenditures and arrivals down by 1.9% and 0.6% respectively. However, excluding Maui, these figures show strong gains of 6.4% and 7.6%, reflecting continued growth in U.S. mainland visitors and significant growth in the Japan market, which increased expenditures by 57.8% and arrivals by 84.3% compared to last year. RevPAR remains steady, and residential real estate on Oahu is stable with moderate increases in median prices for both single-family homes and condominiums. Now, I'll turn the call over to Brad.

Bradley Shairson, Chief Risk Officer

Thanks, Peter. Before beginning, I'd like to acknowledge my predecessor, Mary Sellers, who recently retired after leading risk management here at Bank of Hawaii for the last 19 years. Her vision and development of a strong team laid the foundation for continued sound risk management going forward. During her time, Mary oversaw the refocusing of the bank's credit philosophy towards lending in our core markets and to longstanding relationships. This has greatly contributed to the strong performance of our lending book for many years. As Bank of Hawaii takes great pride in serving our community, our loan portfolio is 92% Hawaii, 5% Western Pacific, and just 3% Mainland, and those Mainland loans are supportive of our core client relationships. As I walk through our current state, you'll note there really hasn't been much change from last quarter. The lending philosophy I just mentioned is reflected in our loan growth, which has been steady and organic. From the end of 2019 to the end of last year, we averaged about 6.5% loan growth per year. On the consumer side, which represents 58% of our total loans or $8.1 billion, we are predominantly lending on a secured basis against real estate. 85% of our portfolio is comprised of residential mortgage or home equity, with a weighted average LTV of 51%. The remaining 15% of the portfolio is a combination of auto and personal loans, where our average FICO scores are 732 and 758, respectively. Moving on to commercial. Our portfolio size is $5.8 billion, or 42% of our loan book. The largest share of commercial is commercial real estate with $3.7 billion in assets, which equates to about 27% of total loans. This book is well diversified across industries and carries a weighted average LTV of only 56%. Given CRE is getting a lot of attention in the industry, let's take a deeper look at our portfolio, which does differ from the Mainland. Starting with the stability of our real estate market in Oahu, vacancy rates remain stable, reflective of the Hawaiian economy and history of limited supply. Industrial vacancy has continued to hover around its historic low, currently just 0.64% versus its 10 year average of 1.75%. At 13.45%, office vacancy is slightly less than a percent higher than its 10 year average. Office conversions and a long-term trend of office space reduction will likely continue to temper vacancy rates there. Retail and multi-family vacancies remain on par with historical averages. A big part of the story here in Hawaii relates to a lack of available land for new construction, which has caused this long history of limited supply across all property types. Looking at industrial, square footage has increased by only 1.2 million square feet, or 0.3% annually over the last 10 years. Similar stories for both retail and multi-family, which have increased 0.7% annually over that same time period. Office space has actually come down 1.5 million square feet, or 1.1% annually for a total 10% reduction over the last 10 years, and that trend continues with conversions from office to condo or even hotel. The limited inventory across all property types makes for greater opportunities for re-purposing real estate when supply and demand balances shift. Additionally, that lack of new construction prevents overbuilding and creates resiliency and durability. You just don't see a cyclical nature here to CRE supply in Hawaii, which on the Mainland has been known to lead to boom and busts. Turning to our lodging market. You can see that the same story on inventory applies to hotel space with no additional square footage over the past 10 years, in fact, a slight decline of 0.03% annually. Additionally, RevPAR and occupancy rates have been trending solidly upward as international visitors, including those from Japan have continued to recover from the pandemic. Our CRE is well-diversified amongst property types with no sector being greater than 6.5% of total loans. Our conservative underwriting has been applied consistently across those different property types with all weighted average LTVs below 60%, and our scheduled maturities have no maturity wall with only 5.1% of loans due to mature this year and 9.7% next year and more than half of our loans are maturing in 2030 or later. Looking at the distribution of LTVs, the tail risk in our CRE portfolio for any loans with greater than 80% LTV totals $37 million, or just 1%, and if we move that metric up to 82%, our CRE portfolio has less than $10 million of exposure, and that's less than a third of a percent. Our office exposure remains low and manageable with only 1.1% of the portfolio in criticized and only 6% of office loans have LTV greater than 80%. Our maturities over the next two years total less than 4% or $14 million of our total outstanding office exposure. Additionally, just 23% of office space is located in Downtown Honolulu, with average LTVs of 60% and 44% of those carry guarantees. Turning to our multi-family portfolio. Only 0.6% of the book, or about $5 million has LTV greater than 80%, and this is a market where the severely limited supply, combined with the high cost of ownership, drives consistent strong rental demand. Scheduled maturities over the next two years are less than 20% and more than 65% of the book does not mature until 2030 or later. Looking at our credit metrics overall, this past quarter compared to linked quarter, metrics remain quite stable and asset quality remains strong. Net charge-offs were $2.3 million at 7 basis points annualized, up 2 basis points from Q4, but down slightly from a year ago. Non-performing assets have remained stable at around 9 basis points for the last year. All non-performing assets are secured with real estate with a weighted average loan to value of 58%. Delinquencies and criticized loans are also stable, with delinquencies flat at 0.31% from prior quarter and criticized loans up 4 basis points from the prior quarter to 1.97%. The allowance for credit losses on loans and leases was $147.7 million at the end of the quarter, that's up $1.3 million for the link period and up $4.1 million year-over-year. The ratio of our ACL to outstanding was 1.07% at the end of the quarter, and that's up 2 basis points from the prior quarter and up 3 basis points year-over-year. I'll now turn this over to Dean for an update on our financials.

Dean Shigemura, CFO

Thank you, Brad. In the first quarter, we maintained our hedging program with $3 billion of notional pay fixed receipt float interest rate swaps and we continue to direct investment portfolio runoff into cash at attractive yields. These actions have increased our floating and adjustable rate asset exposure to 45% from 27% at the end of 2022 and positioned us well for this uncertain environment in a range of interest rate outcomes. Net interest income was $113.9 million in the first quarter, a decrease of $1.8 million linked quarter. Repricing from asset cash flows contributed $4.7 million of additional net interest income linked quarter, while continued deposit mix shift and repricing, as well as a smaller balance sheet from lower deposit balances subtracted $5.5 million. In addition, net interest income was also impacted by one less interest earning day in the quarter, as well as $200 million of our fixed-to-float investment securities resetting during the fourth quarter, which reduced portfolio interest income by approximately $700,000 on a linked quarter basis. As a result, net interest margin declined by 2 basis points linked quarter. As noted earlier, our assets continue to reprice higher, supporting net interest income and the margin even as fed funds remain unchanged. In the first quarter, cash flow from maturities and prepayments was $806 million. We continue to enjoy greater than 3% spread on cash flow from fixed and adjustable loans being reinvested into like assets and investment securities, cash flows, being reinvested into cash while maintaining healthy yields on reinvested floating rate loans. We continue to forecast annual cash flows from maturities and paydowns of loans and investments to be $3 billion, which will provide an ongoing supplement to the $7.2 billion in assets, which include our interest rate swaps, that reprice annually. As a result of these cash flows repricing, our assets higher, our overall asset yields have steadily increased and are expected to continue to increase as new asset yields are well in excess of run-off yield. As Peter mentioned, the rate of growth in our deposit costs has slowed significantly in the first quarter through disciplined pricing, which is expected to continue, as well as through growth of lower cost and more granular consumer deposits, which increased $109 million linked quarter. However, as the outlook for rates has shifted from six rate cuts to a higher for longer rate scenario, we expect continued pressure on our deposit mix and pricing to result in slightly higher overall deposit costs. Non-interest income totaled $42.3 million in the first quarter, unchanged from the fourth quarter, as market conditions and transaction volumes were steady. We expect core non-interest income to be slightly lower in the second quarter, due to recent market volatility. During the first quarter, as is our practice, we managed our expenses in a disciplined manner as inflationary conditions continue. Expenses in the first quarter were $105.9 million, which included $2.2 million of seasonal payroll taxes and benefits related to incentive payouts and restricted stock vesting. In addition, we recognized $500,000 of severance expenses in the quarter. Thus, the adjusted core expense level in the first quarter was $103.2 million. Core expenses in the fourth quarter were $102.9 million, when adjusted for the industry wide FDIC special assessment that resulted in a $14.7 million charge, as well as $1.7 million of expense savings, not expected to recur. Thus the adjusted core expense level in the first quarter was $300,000 or 0.3% higher linked quarter. We continue to evaluate expense levels and have revised our expected normalized expenses in 2024 to increase 1% to 2% from 2023 normalized expenses of $419 million, and this is lower than our prior guidance. In the second quarter, we expect to recognize an additional non-recurring industry-wide FDIC special assessment. The FDIC has indicated that we will be informed of the actual amount in June. In addition, I want to note that the annual merit increases took effect at the beginning of April and are included in the expense guidance. To summarize the remainder of our financial performance in the first quarter of 2024, net income was $36.4 million and earnings per common share was $0.87, increases of $6 million and $0.15 per share, respectively. Our return on common equity was 11.2%. We recorded a provision for credit losses of $2 million this quarter. The effective tax rate in the first quarter was 24.7%. The tax rate in 2024 is expected to be approximately 24.5%. As has been the experience since the first quarter of 2023, we continue to organically grow our capital from prior quarters and we continue to maintain healthy excesses above the regulatory minimum well-capitalized requirements. Our risk weighted assets to total assets ratio are well below peer median, reflecting the low-risk nature of our asset mix. During the first quarter, we paid out $28 million to common shareholders in dividends and $2 million in preferred stock dividends. We did not repurchase shares of common stock during the quarter under our share repurchase program. And finally, our Board declared a dividend of $0.70 per common share for the second quarter of 2024. Now, I'll turn the call back over to Peter.

Peter Ho, CEO

Great. Thank you, Dean. That concludes our prepared remarks. We'd be happy to entertain your questions at this time.

Operator, Operator

Thank you. At this time, we'll conduct the question-and-answer session. Our first question comes from Jared Shaw from Barclays. Your line is now open.

Jared Shaw, Analyst

Hi. Good morning.

Peter Ho, CEO

Good morning.

Jared Shaw, Analyst

Thank you for the questions. To start with margin, as we see the securities cash flows continue to decline and cash also decreased this quarter, how should we consider the trajectory of margin in light of the expectation that there may still be some lingering effects on deposit costs over the next few quarters?

Peter Ho, CEO

Yeah. So when you look at our asset side of the balance sheet and the repricing from our cash flows, we continue to expect approximately, in total, about $5 million of accretion NII and then on the liability side, on the deposits, with the higher for longer interest rate environment, we do expect the deposit remix and repricing to continue somewhat, but at a much, much lower rate than what we've been experiencing and what we had experienced in 2023.

Dean Shigemura, CFO

We observed a significant flattening of deposit costs, particularly late in the fourth quarter, around November 2023. From January to November 2023, average total deposit costs increased by about 11 basis points per month, but since November, that growth rate has slowed to about 2 basis points per month. While this marks a substantial decrease, it still represents a positive movement. It's uncertain whether this will decrease further to 1 basis point or even zero, and we're optimistic but cautious. Therefore, for the quarter, the net interest income will largely depend on the accretion we receive from fixed asset cash flow compared to our funding costs. Last quarter, we believed we had a fair chance of coming out ahead, but that didn't happen due to some one-off items. We'll have to wait and see how this quarter unfolds. The numbers are becoming increasingly tight, making it difficult to make any predictions.

Jared Shaw, Analyst

Okay. Good color. Thanks. And then shifting, I guess to capital, you continue to grow capital, really strong levels there, and you mentioned the buyback authorization, what's the general feeling with buying back stock here? And I guess, at what point is capital getting too high given the broader growth profile staying in that, call it, longer term 6% range?

Dean Shigemura, CFO

Yeah. So I think a lot to think about on the capital front, both from an operational standpoint, as well as from a top down regulatory standpoint or just kind of the broader industry perspective. And so, I think kind of from the top down, there's still a fair amount of uncertainty around where banks are going to be pushed to hold capital levels from the bottom up. It still feels like there's a fair amount of caution, I'd say, in the marketplace and so we think that growing capital is thought of as a good idea in the eyes of our shareholders and therefore probably a better idea than the alternative of stock repurchase for now. Now, greater clarity from the top down would be helpful. Improvement in kind of the bottom-up environment would be helpful, and that probably begins to change our trajectory over time.

Jared Shaw, Analyst

Got it. Thanks very much.

Dean Shigemura, CFO

Sure.

Operator, Operator

Thank you. One moment for our next question. Our next question comes from the line of Jeff Rulis D.A. Davidson. Your line is now open.

Jeff Rulis, Analyst

Thanks. Good morning.

Peter Ho, CEO

Hi, Jeff.

Jeff Rulis, Analyst

Peter, just to maybe follow on, it follows that you talked about deposit costs sort of by month 2 basis points, interested in the spot rates on both interest bearing and total deposit costs, how do those compare to the full quarter averages?

Peter Ho, CEO

Sure. The total average deposit cost for March was 177, and the average interest-bearing deposit cost for March was $2.42.

Jeff Rulis, Analyst

Okay.

Peter Ho, CEO

Yeah. So, pretty flat.

Jeff Rulis, Analyst

The average deposit cost is about 3 basis points higher than the quarterly figure, which suggests a trend that is leveling off. I wanted to confirm that number. If we shift focus to the loan pipelines, I've heard from various sources that the expectation for higher rates to persist might have paused earlier in the year regarding rate cuts. Some customers still seem to be holding onto that hope, but with the higher rates lasting longer, are you observing any changes in your loan pipelines or are people adjusting to the current rates in a way that is enhancing the pipeline situation year-to-date?

Peter Ho, CEO

Yeah. Jeff, the pipeline has been interesting, and in spaces where we get some rate relief, we've seen good movement, I'm talking more on the residential lending side, some good pickups in volumes, and then as rates begin to crest again as they have most recently, you see that demand fall up pretty quickly. So our resi was down 0.6% for the quarter on an average basis. Home equity was down 1.1% on an average basis. We were hoping for a flattening this quarter. We'll see if we get that depending on how rates fall out. But my outlook for or our outlook for the balance of the year is pretty flat and that's based on; one, a belief that rates are possibly higher for longer, so not a lot of confidence in rate relief; and secondly, I think in part that's driving the consumer to be a little bit more cautious, both the consumer as well as, I think, the commercial and commercial real estate customer.

Jeff Rulis, Analyst

Thank you, Peter. I have one last question. The statistics you've shared are really interesting; I wasn't aware that the industrial real estate vacancy rate is so low. I'm also curious about the history of office to industrial conversions on Oahu and the factors influencing that. I'd like to hear more about that if possible.

Peter Ho, CEO

The conversion from office to industrial is limited for several reasons, including the specific configurations of the real estate and the challenging entitlement process in Hawaii, making such conversions difficult. However, we are seeing a significant amount of conversion from office to multi-family housing, particularly in the Downtown corridor. This is a positive development as the office market, while not dire, has a vacancy rate between 12% and 13%, and we are experiencing a housing shortage. We are beginning to observe some positive signs in this area, suggesting a trend towards converting office space into housing rather than industrial. The issues surrounding the industrial sector, including high vacancy rates, are creating various operational challenges on the island.

Bradley Shairson, Chief Risk Officer

I'll just add really quickly that when you look at that graph, you can see that office space has come down a little more in the past five years than the previous five. So it's down 1.2 million square feet in the last five years and there are forecasts out there for it to come down another 400,000 square feet or so in the next three years.

Jeff Rulis, Analyst

Okay. Thanks, Brad and Peter. Appreciate it.

Peter Ho, CEO

Sure.

Operator, Operator

Thank you. One moment for our next question. Our next question comes from the line of Andrew Liesch of Piper Sandler. Your line is now open.

Andrew Liesch, Analyst

Thanks. Good morning, everyone. Just curious what you guys are seeing on deposit trends. It sounds like you had some public funds leave and then some Lahaina-related fire relief efforts, deposits leave, but do you think you've reached a point of stabilization in the mix that you can grow deposits from here, or I guess, what are you hearing at the individual client level?

Peter Ho, CEO

Yeah. Good question, Andrew. So there was some bumpiness as you saw in the numbers from Q4 to Q1, and really, the way to think about it is Q3 to Q4 to Q1, and so, Q3, we were at $20.5 billion average deposits, Q4 we spiked $20.7 billion, and then now for this past quarter, we're down to $20.5 billion, and that run up in Q4 had a lot of Maui insurance and essential aid type of money, that kind of flowed in in the quarter and then flowed out in the quarter. So I think that probably the number to go off of for the foreseeable future is kind of that 20.5 billion mark, that seems pretty durable. And what we're seeing amongst deposit mix is a pretty meaningful slowdown in mix shift from non-interest bearing to interest-bearing. So if you look at '23, kind of the first three quarters of '23, that runoff in non-interest bearing was about $98 million per month, and then kind of from Q4 '23 to current, that number's down by about a third of that, like $33 million. So I'm not sure that we're completely done with kind of runoff in non-interest bearing, but as you can see, the rate of runoff has slowed pretty dramatically. And frankly, we were thinking that as we got a rate cut or two, that would kind of mark the end of that period, but that seems like that may be pushed out a little bit at this point.

Andrew Liesch, Analyst

Got it. Okay. That's really helpful there. And then, Dean, just on the expense guidance, so the $419 million, the 1% to 2% growth off that, that does include the seasonal impact that you had in the first quarter at $2.2 million, correct?

Dean Shigemura, CFO

Yeah. It does include the $2.2 million, but would exclude the second special assessment of the FDIC.

Andrew Liesch, Analyst

Thanks for the clarity. Since you've addressed all my other questions, I’ll step back. Appreciate it.

Dean Shigemura, CFO

Thank you.

Operator, Operator

Thank you. One moment for our next question. Our next question comes from the line of Kelly Motta of KBW. Your line is now open.

Kelly Motta, Analyst

Hi. Good morning. Thanks for the question. I might circle back to the margin, looking at Slide 34 with the $800 million of loans and investment portfolio flows coming in Q1. I was surprised to see earning asset yields only increased 4 basis points this quarter. I was just wondering if there was anything unusual or any kind of factors to consider as we think about the dynamics of the repricing of your book in a higher for longer environment.

Peter Ho, CEO

Yeah. One thing to point out is that, as I mentioned, the investment portfolio, we had some securities that repriced fixed to flow, that brought down the yield on the investment portfolio, so that had an impact. And then, in addition, the loan volume came down, balances came down, so that also had an impact on the overall yields. If we had stayed flatter, the increase would have been greater.

Kelly Motta, Analyst

Okay. That's helpful. Going back to the earlier Q&A, I believe you mentioned that you expect about $5 million in net interest income from earning asset repricing over the next couple of quarters. Could you clarify if that's for the year or just for next quarter? I want to ensure I understand that correctly.

Peter Ho, CEO

It's per quarter.

Dean Shigemura, CFO

Yeah, per quarter.

Kelly Motta, Analyst

Thank you. I appreciate it. For my last question, credit is clearly a strong point for the bank, and I really liked the slides on asset quality, which emphasize how robust everything is. I know that a portion of the office portfolio matures in 2026, and I'm curious if you've begun proactively reaching out to those borrowers to assess how things are expected to perform. While this segment isn't large compared to the total office portfolio, I would like to know if there has been any proactive engagement with those borrowers and if you can share any initial insights.

Peter Ho, CEO

We maintain strong and meaningful relationships with our customers, which is a key advantage for a bank of our size. We stay in regular contact with our clients across various loan types, including in the office sector, where we're not currently experiencing significant stress. Therefore, there is no immediate need to consider restructuring or adjustments to loans at this time. However, if conditions change, we will certainly engage in more frequent discussions. For now, we feel confident about the performance of that segment of our portfolio, despite it being office-related.

Kelly Motta, Analyst

Appreciate it. Thanks for the color, Peter.

Operator, Operator

Thank you. This concludes the question-and-answer session. I would now like to turn it back to Chang Park for closing remarks.

Chang Park, IR Manager

Thank you, everyone, for joining us today and for your continued interest in Bank of Hawaii. As always, please feel free to reach out to either Cindy or me if you have any questions on any of the topics discussed today. Have a great day.

Operator, Operator

Thank you for your participation in today's conference. This does conclude the program. You may now disconnect.